Moody’s has welcomed Bank of Cyprus’ deal to sell a portfolio of loans with a gross book value of €2.8 bln to Apollo Global Management LLC, a global alternative investment manager but risks remain.

The loans are predominantly nonperforming exposures (NPEs) in the bank’s corporate and small and midsize enterprise portfolio totalling €2.7 bln and are secured with real estate collateral.

“The sale, for a consideration of €1.4 bln, will significantly reduce the bank’s nonperforming exposures and increase its capital buffers upon completion, a credit positive,” said Moody’s.

This is Bank of Cyprus' first sale of NPEs as part of its effort to accelerate the de-risking of its balance sheet.

It is also the largest sale of NPEs in Cyprus, whose banks are saddled with significant volumes of problem loans.

The transaction remains subject to regulatory approvals, including the European Central Bank's approval for Bank of Cyprus to recognize a significant credit risk reduction from the transaction.

Bank of Cyprus announced its intention to finance €450 million of the portfolio's purchase consideration through senior debt, pending regulatory approval, with the equity portion provided by funds affiliated with Apollo.

According to Bank of Cyprus, the €2.7 billion reduction in gross NPEs will improve its NPE/gross loan ratio by 10%. The bank reported an NPE/gross loan ratio of 43% as of June 2018, which will increase to 48% following the sale of its UK subsidiary announced in July and the resulting fewer performing exposures.

After the completion of the NPEs sale, Bank of Cyprus' NPE/gross loan ratio will improve to 38%.

“The sale to Apollo is equivalent to six quarters of organic NPE reduction, with the bank reporting an additional €435 mln of NPE reduction during second-quarter 2018,” said the ratings agency.

“The sale accelerates the bank's balance sheet de-risking and reduces net NPEs to €2.7 bln, a 72% decline since peak NPEs of €9.9 bln in December 2014,” it added.

The €1.4 bln consideration, which is equivalent to 48% of the portfolio’s gross balance sheet value, and the associated transaction costs resulted in a €135 mln loss in first-half 2018 results, with Bank of Cyprus reporting a net loss of €54 mln.

Net of this effect, the bank reported a CET1 ratio of 11.9% as of June 2018. However, completion of the transaction will add 140 basis points because risk-weighted assets will decline, leading to a 60-basis-point net positive effect.

Following completion of the NPE sale and the disposal of the UK subsidiary, the bank’s pro forma CET1 ratio will increase to 14%.

The sale of NPEs adds to the bank's existing tools to clean up its balance sheet from legacy exposures, which include debt restructurings and collections, write-offs and debt-for-asset swaps.

Bank of Cyprus is targeting an organic NPE reduction of €200 mln per quarter.

“However, the bank’s NPE ratio remains among the highest of our rated banks and is a key credit challenge, with the coverage of these troubled loans at a relatively low level of around 50%,” warned Moody’s.

The credit positive analysis follows a similar endorsement from S&P last week.